The Bank of England says growing reliance on debt to fund the AI infrastructure boom raises the risk of a market correction sharper than the one seen over the summer. Its Financial Policy Committee flagged a doubling in AI-related debt issuance and warned that rising leverage at hedge funds betting on UK government bonds adds to the danger.
AI debt issuance more than doubles
The Bank of England warned on Wednesday that the financial system faces the risk of a sharper correction than it experienced over the summer, pointing to the growing use of debt to fund the artificial intelligence infrastructure boom. AI-related debt issuance totalled $450 billion in the year to September, more than double last year's total, the Bank said, citing estimates from Morgan Stanley.
Its Financial Policy Committee added that global AI-related debt sales are expected to exceed the amount of bonds sold by the UK government this year. Shares in AI-linked companies and semiconductor makers slumped in July before recovering as investors weighed the technology's earnings potential.
The Bank said the risk of a sharper correction persists, particularly if earnings expectations tied to AI face a bigger shock than expected, though it added the financial system has held up so far. The committee also warned that if AI-driven productivity gains fail to lift economic growth as much as forecast, the hit would extend beyond AI-related asset valuations to sovereign debt markets.
Bailey says regulators cannot stand aside
Governor Andrew Bailey wrote in a blog published Wednesday that regulators cannot assume the AI industry will resolve the risks it poses to financial stability on its own, pointing to the possibility of advanced models going rogue or being used in cyber attacks. According to Bailey: "we should not automatically turn to the question of regulation" — he added that understanding, testing and establishing credible points of intervention must come first.
Leverage and gilt market risks
The Bank said overall vulnerabilities in the financial system have increased in recent months, citing the war in Iran and the subsequent surge in energy prices, persistent inflationary pressures, high government debt levels and rising interest rates. It also said high leverage at hedge funds betting on UK government bond markets is intensifying the risk of a correction.
Separately, the central bank confirmed it will proceed with a planned reduction in capital requirements for UK banks by easing the leverage ratio, which sets how much capital lenders must hold against their total assets. It warned this would lead to a meaningful increase in the leverage banks extend to hedge funds for betting on government debt markets, an area already of concern for officials — bank lending in gilt repo markets to hedge funds and other non-banks has roughly doubled to about £200 billion since 2023.
As a result, the committee said it will examine market-based measures for gilt repo markets, such as increasing requirements for central clearing or setting minimum haircuts, and plans to publish its proposals early next year.
Source: Financial Times
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